Notes of interest from this morning’s American Airlines earnings call

American Airlines reported Q4 and 2014 full year results today and the numbers were, as expected, mostly good. Profit for the year was either $597mm or $4.2bn, depending on which set of numbers you choose to care about and, generally speaking, the management team was upbeat during the call. There were a few specific topics of interest to me which were mentioned on the call which I think are worth sharing.

Want to know where American will fly its new 787s? So does everyone else. And management is not saying anything on the topic. It will be a while yet before it is in service at all and the initial commercial route(s) will be domestic but no indication which domestic route(s) will get the flights. The only hint of anything concrete came when a reporter from the Charlotte Observer asked if the 787 would change the landscape for international service from his hometown. The answer there was a decidedly strong “no.” In fact, the company doesn’t even expect to see the plane visit Charlotte on a proving run during the break-in period.

It is worth noting that, despite a lack of a formal announcement from the company, all indications are that the 787s will initially be based in DFW. Part of this is just logic and part is based on reports from pilot bid options which have come in off the record. Of course, that doesn’t mean that the routes served will all be ex-DFW; just look at how United is using the 787s from its Houston base to serve many other routes. But expect DFW as the 787 base to start.

On Fuel – Hedging & Otherwise

Historically this management team has been rather aggressive in an anti-hedging position. During the call the topic came up again and we were reminded that a similar inquiry was raised when “oil dropped from $115 to $103” and there was the implication that we really just have no idea. And, while there was acknowledgment that the downside to hedging now is much lower than at $103/bbl, the company remains disinclined to pursue such a path. Possilby slight paraphrasing below but this is generally what they had to say on the topic:

We cannot buy oil at today’s prices far out in the future. Somehow you have to convince yourself that you know better than all the professionals trading in the oil market. … But the theoretical rationale for not hedging has not changed; the downside is just lower.

Similarly, a question came up regarding the potential hit the company would take in losses of revenue related to Texas-based energy companies as the price of oil continues to drop. While AA does not have 100% visibility into all the traffic which is based on the energy sector it does know about corporate contracts. And they make up a relatively small piece of the pie.

For corporate accounts…I believe it is <1% for energy contracts. That’s a tradeoff we’re happy to make in exchange for lower energy costs.

No doubt that cheaper fuel is worth more, at least right now, than the de minimis hit in traffic seen from reduced travel by that sector.

American wants to be big in Asia

The new Asia routes have, for the most part not been profitable. Yet.

The company typically allocates a “couple of years” for an Asia route to spool up, particularly a destination like Seoul where there has not been a presence previously. On the plus side, with the lower fuel costs American is predicting that all the Asia routes will be profitable in 2015, even the new ones which are still establishing themselves.

Also worth noting that, after the launch of DFW-PEK which was recently announced, the company expects that growth to Asia ex-DFW is probably done for a while. But Asia still holds opportunities with untapped markets. Expect to see that growth based in Los Angeles.

CASM v PRASM

PRASM took a hit, among other things, because 221 of American’s 737s have 10 more seats now than they did a year ago. The incremental seats are selling at 65% of average PRASM which leads to an overall 0.4% hit on PRASM numbers in the system. And that might seem bad if PRASM is the only number you consider. But the CASM on those additional seats is so low that adding them “is P&L positive” for the company. Just a reminder to consider all the numbers, not just one particular value, when evaluating the overall financial health of an airline.

Pricing & Product

Fuel costs are coming down, so why aren’t prices? It isn’t that American thinks customers should just “learn to be happy” with higher fares, but the company isn’t going to be cutting them any time soon. Pricing is tied to demand more than costs which explains why local yield in the DFW area took a hit when Love Field opened up and why DCA took a hit as JetBlue showed up (AA claims 50 markets affected but few details on that number). Rather than cutting fares the company is taking those profits and investing in the product.

On the plus side, the company acknowledges that it trails the competition on product quality and that things need to improve.

Our job is to make sure we’re giving the best product we can to our customers. … We are using the profits we’re producing to invest in the product which matters to our customers: Lie-flat seats, international wifi, Admirals Clubs, Check-in areas. … We believe we will be leapfrogging our competitors.

The real question is if the changes truly do represent a “leapfrog” of the competition or just catching up. Yes, the new AA lie-flat business class seats also come with direct aisle access, but they are arriving slowly and the competition will have had flat beds in business class for years longer in many cases. And the company trails in international wifi by a ways as well.

And there is the part where the competition also has big piles of profits to play with in terms of improving their product. Surely Delta and United are going to find ways to spend some of their massive profits to keep the pressure on American and each other.

Cuba

American currently runs 20 weekly flights to Cuba as charter operations and is well positioned to expand that into commercial service when the opportunity arises. The company went so far as to say it is “anxious to serve Cuba on a scheduled flight basis” but stopped short of naming routes. Miami seems the obvious lead contender there.

5 Responses

American really needs to think about using DFW as an Asia hub. DFW is very poorly located in the US for connecting traffic. Sure, they might get a little LatAm connecting traffic but who on earth would want to connect at DFW instead of ORD or LAX? I’m biased being based in Chicago but I think AA is making a mistake and will lose a lot of connecting traffic to other airlines.

See how cheaply DFW – HKG is priced on AA vs. other US non-stop routes or how empty DFW – ICN is.

They explicitly said that they’re budgeting a couple years – not just a few months – for those routes to grow into the desired loads generally considered good for the carriers. And LatAm is a much bigger pull than you give it credit for. The flights are very well timed to support those connections. Push everything east of Dallas and South of DC, including LatAm via DFW. Mountains and west goes via LAX and the Mid-Atlantic and Chicago/Upper Mid-West goes via ORD. Makes a lot of sense, actually.

Well, American really wants to serve LAX-HND so that’s certainly one to consider. It would also be interesting to see if they try to pick up a secondary market the way UA did CTU, though I’m not sure that’s going to happen.

DFW as a hub isn’t that bad of an idea for Asia traffic as there is significant Asian population in Texas. It’s also a warm weather hub unlike ORD but in reality I would assume any major airport on the West coast, NY, Chicago, Dallas and maybe Atlanta would all be viable for Asia routes.